Can oil pay for Scottish independence?

“Norway’s experience offers a number of important lessons for Scotland”

What can Scotland learn from Norway? A lot, as it happens. Norway has the same sized population; like Scotland, it also picked up one of the golden tickets of North Sea oil. Yet Norway has income per head almost double that of Britain. Perhaps most startling, the country has won for itself a trophy many might assume would belong to a Gulf state—amassing the world’s largest sovereign wealth fund. Last year, when the Scottish government’s Fiscal Commission Working Group published its paper on how an independent Scotland should manage North Sea revenues it said that Norway’s experience “offers a number of important lessons for Scotland.”

There’s a reason why it’s now suddenly fashionable to talk about “the Norwegian model”. Norway’s sovereign wealth fund—a fund of national wealth, owned by the state, which invests globally—is attracting a lot of attention. In just 18 years this country of some five million people has amassed the largest in the world: an $885bn giant known as the Government Pension Fund Global (GPFG) that far outstrips the funds owned by countries such as Kuwait, Saudi Arabia and the United Arab Emirates, all of which were established long before it. Today, Norway’s sovereign wealth fund is nearly twice the size of its GDP and contains more than a million krone (£100,000) for every member of the population. In July, Nigeria’s Business Day newspaper asked: “Can oil revenue make every Nigerian a millionaire?” before describing “the Norwegian model” in detail.

The commission in Scotland is far from alone in wanting to follow this path. Andrew Bauer, senior economic analyst at the Natural Resource Governance Institute [where, which country?], which advises governments on how to set up and manage resource funds, says: “There have been about 30 new funds created since 2000 around the world. There are about 14 countries right now that are creating or thinking about creating funds.” Today, a sovereign wealth fund is the must-have national accessory for an upwardly mobile developing nation and almost everyone who sets one up has Norway in mind. “In some sense, sovereign wealth funds have become the national airlines or the stock markets of the modern mineral or oil-rich state,” Bauer observes.

Quite apart from national bragging rights, however, there are powerful economic reasons why a country—and particularly one with a relatively small population—that comes into a lot of money should consider setting up a sovereign wealth fund. A huge lottery win, such as Norway experienced, brings headaches as well as unimagined bounty. The more reliant an economy becomes on revenues from oil or minerals, the more exposed it is to changes in the price of those resources—if the price of oil drops, the government can quickly find itself running out of money. One reason, therefore, that countries decide to salt some of their resource revenues away is to smooth out those “boom and bust” cycles and allow them to maintain their spending irrespective of what happens to prices. Equally, the Natural Resource Governance Institute suggests a fund may be an effective means of “earmarking revenues for public investments like roads, water systems, hospital equipment and education programmes.” In some cases, funds have been set up to “ring-fence resource revenues to protect them from corruption or mismanagement.”

Probably the most important consideration, however, is “Dutch disease,” shorthand for the economic damage that a country can inflict on itself if it spends the proceeds of a resource boom too freely. Named after the experience of the Netherlands, which discovered gas in the 1960s, it involves big flows of capital into the economy which push up wages, inflation and the value of the currency. This makes domestic companies uncompetitive internationally and can lead to whole swathes of industry disappearing.

For Norway, the big threats that emerged with the increase in oil production from the North Sea were volatile oil prices and the corrosive effects of Dutch disease. As a nation of five million that became a globally significant oil producer, there is no way that Norway could possibly spend all its oil and gas revenues domestically—and very great economic dangers should it attempt to do so.

This explains why the GPFG operates as it does—taking in huge flows of cash from the government and investing all of them outside Norway. A major part of the task that faces Norges Bank Investment Management—the arm of the Norwegian central bank that runs the fund—is to prevent the country from drowning in its own money by funnelling it offshore. As a result, Norway’s $885bn nest egg is invested in more than 80 countries around the world. The GPFG nowadays puts 60 per cent of its money into equities—it owns stakes in about 8,200 companies and has holdings equivalent to roughly 2 per cent of every listed company in Europe. Almost all the remaining 40 per cent is in major government bonds, aside from about 1 per cent in prime commercial property, including part of Regent Street in London.

Norway’s conspicuous success in pursuing this strategy has enabled it to speak with authority on how countries should manage their affairs, so much so that in September 2013 then-Prime Minister Jens Stoltenberg gave a speech at Harvard’s Kennedy School of Government on “Avoiding the oil curse: the case of Norway.” Stoltenberg offered his American audience a triumphal sermon on the virtues of Norway’s GPFG and the rules that govern its operations. “All our oil and gas revenue goes by law into that fund and the only thing we spend is the financial return from the fund,” he said. “So actually we spend zero oil and gas revenue. What we spend is the financial income from the fund—never the instalments. In that way the fund can last forever.”

How did Norway arrive at the happy state of being able to pay for one of the world’s most generous welfare systems—by Stoltenberg’s account in perpetuity—by spending only the interest on its vast oil fund? Can others really hope to follow its extraordinary example? The success that Norway is able to present to the world today is relatively recent. The two decades leading up to the first deposit of oil money into the GPFG offered a rather different story, says Martin Skancke, a former senior official in the Ministry of Finance who now advises on sovereign wealth fund governance. In the early years, a lot of the oil money was spent on “a very expansionary fiscal policy” as well as on subsidies to protect Norwegian industry and agriculture from the effects of the first oil price shock. By the end of the 1970s, wages were rising at up to 20 per cent a year and the country was running a huge current account deficit, partly because of the need to invest in developing its oil reserves. “We were very close to having to ask for an International Monetary Fund stabilisation programme,” he says.

Then Norway had a stroke of luck: the Iranian revolution pushed the price of oil from $10 a barrel to $40. Government income leapt and, as Skancke says, “We entered into the early 80s with a wave of optimism, which fed into high growth in private consumption.” Inflation was high, the krone was repeatedly devalued to aid Norway’s competitiveness and credit expanded hugely. “In 1986, when the oil price fell back to $10 a barrel or so, the economy was very vulnerable and had no resilience to that kind of shock.” The result was a banking crisis in which several of Norway’s largest banks had to be rescued and recapitalised.

“That was the aftermath of the second round of bad management of oil revenues,” says Skancke. “In the middle of this, in 1990, a group of pretty farsighted people at the Ministry of Finance and some politicians decided that if we ever got a third chance to do things right we would do better.” The result was the formal establishment that year of Norway’s oil fund, which had been under discussion at least since the mid-80s.

For the next six years, however, the fund existed in name only. No oil money was deposited until May 1996 and the reason behind this six-year hiatus is vital to understanding why Norway is now the poster child of sovereign wealth funds. In the years since it decided to take its “third chance to do things right,” Norway has developed a highly unusual set of rules designed to ensure national self-discipline where its oil wealth is concerned—a self-control that is contested fiercely across the political divide but that nonetheless has held good so far.

Part of this goes back decades into Norwegian politics and is rooted in the national character, according to Ola Storeng, economic affairs editor at Aftenposten, the country’s largest newspaper, and another former Ministry of Finance official. Since the Second World War, he points out, the country has run almost continuous budget surpluses. “Norwegians were always very puritanical in the way they dealt with their own money,” he says. “In terms of fiscal behaviour, Norway was different even before oil arrived on the scene.”

One of the rules that governs Norway’s fund, therefore, is that no money can go into it unless the government’s budget is in surplus. During the early 1990s, Norway ran deficits to deal with the aftermath of its banking crisis and only returned to surplus in the middle of the decade, hence the six-year wait to start saving. “As the ultimate way of fooling yourself, most countries allow money to be deposited in the oil fund even when there is no surplus in the budget,” says Storeng. That leads to the nonsense of a government appearing to be prudent by saving its resource income while simultaneously borrowing to finance its expenditure. “So you lose completely the view of what the fund is really about. It’s about budgetary discipline. It’s about the hard annual fights over the government’s money.”

The other key rule Norway has developed is that governments can withdraw no more than the assumed annual after-inflation return that the fund generates, which is set at 4 per cent, rather than the capital itself—hence Stoltenberg’s reference to the fund lasting forever. As long as Norway maintains its budget surpluses, all its oil revenue will be put into the fund every year and nothing but the 4 per cent return it is supposed to generate will come out.

Not surprisingly, Norway’s oil and gas bounty plays a central role in the country’s politics, provoking constant debate over how much of the money should be spent. The fund’s activities are reported publicly in great detail—down to a list of every company it invests in—and there is layer upon layer of oversight from within the central bank, the Ministry of Finance and the Norwegian parliament, and groups of outside advisors. In terms of good governance and transparency among sovereign wealth funds, the Government Pension Fund Global sets the benchmark.

The Norwegians’ success in sticking to their self-imposed rules for managing the money and in exposing virtually every aspect of the fund to public scrutiny is a source of deep pride for many, including Stoltenberg, a man Storeng describes as “almost obsessed with the idea of responsible economic policies.” Warming to his theme during his Harvard speech, the former premier allowed a flash of that national pride to burst forth. “The problem in Europe with the deficits and the debt crisis is that many countries have spent money they don’t have,” he said. “The problem in Norway is that we don’t spend money we have.” Achieving that, he told the audience, requires “political courage.”

Much of the rest of the world looks on in amazement at the gargantuan act of thrift that Norway’s politicians have accomplished. They pay attention to Norway partly because of its ability to argue its way to cross-party consensus on how to manage the money, and partly because of the GPFG’s transparency and political accountability. But they also pay attention because Norway makes sure they do. The extraordinary growth of the GPFG, built on collective self-denial, has become a central part of the Norwegian national narrative and one that the country works hard to propagate.

“Norwegians have done a very good job, especially in oil, gas and mineral-rich countries, of publicising themselves,” says Andrew Bauer of the Natural Resource Governance Institute. “They do that directly through country-to-country diplomacy; they do it by sending Statoil representatives to do business in those countries and they do it through proxies—they have something called Oil for Development which is a foreign aid programme where they fund organisations to help countries that are resource rich to develop. But everyone knows where the money’s coming from.” It comes as no surprise to learn that the National Resource Governance Institute is itself partly funded by Norwegian money.

But Norway’s good sense has been matched by its good luck. A big part of the reason the oil fund grew to such an enormous size lay in the way the country chose to manage it. But equally important was what has happened to the oil price over the past 15 years—just as production from the North Sea peaked in 2000 and started to fall rapidly, the oil price started to climb and Norway’s gas production also rose sharply. What could have been a nasty downturn in oil revenues was more than offset by rising prices and gas output: the GPFG ballooned.

Perched atop the world’s biggest stockpile of oil money, Norway seems to have insulated itself from any potential fiscal disasters. Challenges remain, however. Although the country has largely escaped the deindustrialisation that often accompanies big natural resource windfalls, its industry is now much more dominated by companies that service the oil industry and its wage levels over the past decade have risen far faster than in other countries, making it uncompetitive in cost terms.

Ola Storeng argues that because Norway’s oil fund is now so huge, a drop in oil prices would not hurt the government’s finances as much as in the past. “But Norwegian industry’s dependence on oil prices has not been reduced,” he says. “It has increased because everyone is now in oil. So suddenly the oil dependency of the Norwegian economy has changed.”

Similarly, Norwegian society is ageing rapidly and in a decade or so the government will find itself having to spend a lot more on social care. “Now we are in the golden years, because after 2025 we’re going to figure out that the costs associated with every service we provide will double because the number of people who need them will double,” he says.

Julian West, a veteran oil industry executive who worked in the UK’s Department of Energy just as Britain’s North Sea production was coming on stream, echoes these concerns. “Overall, I’m an admirer of the way Norway managed its oil boom, but it was certainly not perfect.” Wage growth was too high and the actual investment returns on the fund were less than stellar, he says, but none of this has turned out to matter much. “If you look at it slightly more broadly, they have done a good job and the sacrifices they made turned out to be smaller than the overall benefit.

“But whatever the Norwegians have done in the past, the game for them is now changing.” As the population ages, North Sea production declines and pressures on government spending grow, the political system that delivered the country its present bounty will face yet sterner tests. “Whether they carry on being the star pupil depends on how they handle the politics,” says West. “That’s what it’s all about.” Something that Scotland might bear in mind.

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